Question

Imagine you consume two goods, X and Y, and your utility function is U = XY. Your budget is $100, the price of Good X is $4, and the price of Good Y is $25. So, the optimal bundle for you to consume is (12.5, 2). Now the price of good X increases to $10. The compensated price bundle is (7.91, 3.16). What is the income effect on X?

Answer 1

PAXI + Pg X 2 =100 Ans AS we are given that the budget = 100 when, Price - SL of X (PI) Price of Y (P2) And the given optimum bundle = (12.5,3) S9.5 X la.S +5Sxa 2 (00 If PI increase to SIO and P2 = 525 the then obtained optimum bundle is (7.91,3,16) But, 10x 7.91 +25 X 3.16 = 158.1 Here the total Price has exceeded from the budget. Even though the Consumer is ready to Purchase the good X even at high Price.

But the Consumer has made small Purchase increase in the Purchase of Y good and small decrease decrease in the of X good. The increase in Price of good has not has not increased much in the Purchase of Y good by the consumer the consumer has not Substituted y good instead of a good entirely. Even though the price increased the demand for a good remained high. this shows that the substitution effect x is less on thank you